The Pacific Coast Oil Trust is deciding whether to drill for oil on a tract of land that the company owns. The company e

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The Pacific Coast Oil Trust is deciding whether to drill for oil
on a tract of land that the company owns. The company estimates
that the project would cost $16 million today. Pacific Coast Oil
Trust estimates that once drilled, the oil will generate positive
net cash flows of $8 million a year at the end of each of the next
3 years. While the company recognizes that if it waits 2 years, it
would have more information about the local geology as well as the
price of oil. Pacific Coast Oil Trust estimates that if it waits 2
years, the project would cost $18 million. Moreover, if it waits 2
years, there is a 75 percent chance that the net cash flows would
be $ 10 million a year for 3 years, and there is a 25 percent
chance that the cash flows would be $4 million a year for 3 years.
Assume that WACC is 0.10. What is the project’s NPV if company
chooses to wait 2 years, there is a 75 percent chance?
a.
$6.86 million
b.
no one of the answers
c.
$3.9 million
d.
-$8.05 million